Maintaining perspective and ignoring the ‘noise’

Investors can be forgiven each morning for scratching their heads when they pick up their daily newspaper, fire up their PC, or switch on their iPad.

The business headlines are either screaming doom and gloom, or conversely suggesting that the worst is over and that recovery is on the way.

Certainly, there is little in the way of considered analysis that is provided for the sophisticated resource sector investor.

As I write this I’ve just sifted through more headlines related to the Greek debt situation etc and other current attention-grabbing issues.

Financial markets rally one day and weaken the next. Sophisticated, reasonable resource investors are left none the wiser.

If they follow the headline scribblers they’d be desperately ditching their portfolios one minute, then scrambling to buy them back the next.

Little wonder that even the most experienced of investors probably entertains some doubt about their medium to longer-term investment strategies.

Conversely, now is the time to remain focused about one’s resource investment strategy, ignoring the ‘noise’ and reminding one’s self of the strong medium to longer-term factors that make the resource space the place to be.

For reassurance, one only has to examine the demand-supply dynamics of the world’s most important commodities (in no particular order): copper, oil, coal and iron ore.

I’ve been at pains to reinforce the bigger picture with respect to all of these commodities; essentially the production-side issues that necessitate strong future prices to ensure adequate supply in the face of growing emerging world demand.

This situation isn’t going away – in fact it’s getting worse. Let’s examine two of these examples, copper and oil.

The copper market is a perfect case in point. Whilst demand in the emerging world continues to climb, particularly for residential and commercial construction, the supply-side is being threatened by the terminal decline in grades at the world’s biggest copper mines.

Without exception, all of the world’s biggest copper operations in North America, South America and Asia, are faced with steadily declining production as operations become more mature.

You only have to check out the quarterly production reports of BHP Billiton and Rio Tinto to see that all of their major copper operations are in the midst of grade and production decline.

At BHP and Rio’s jointly-owned Escondida mine in Chile, output is set to fall by as much as 10% during 2011 because of declining grades.

Freeport-McMoRan expects production to fall by around 17% during 2011 from its massive Grasberg mine in Indonesia, and Anglo American has seen a 14% drop in production during the first quarter from its Collahuasi and Los Bronces mines in Chile.

The London-based research company, CRU, estimates that average worldwide copper grades have fallen from 0.9% Cu in 2002 to 0.76% Cu in 2009.

To remedy the situation, the world’s biggest miners now have to search in riskier global destinations, typically for deposits that are deeper, lower-grade and more costly to develop.

This is why I am hugely positive about the outlook for copper. Companies will demand higher prices in order to push the button on the huge expensive projects needed to meet future demand.

The situation is even worse when we examine the crude oil market. Decades of under-investment in both infrastructure and exploration by all OPEC nations has left the world oil market precariously placed.

Forget what you read about weekly US oil inventory data. The US is no longer king of the block as far as oil is concerned and most of the US-centric oil research fails to recognize this.

The last OPEC meeting ended in farce, as Saudi Arabia’s push to lift production levels never came close to being approved.

Saudi Arabia has pledged to keep the world supplied with extra crude, but the cushion that the Saudis can provide isn’t as cozy as the hype.

The Saudi oil industry in my view is rapidly approaching a crucial turning point, where fields will start to deplete at an increasingly rapid rate.

And even if the Saudis could open up the taps in a big way, which they can’t, Saudi crude is heavy, sour and refiners hate it.

Most of the world’s major refiners are geared for better quality, lighter, sweeter crude.

What most oil insiders know is that OPEC has virtually no capacity to boost production levels by any reasonable margin and for any significant period of time.

The world’s major oil fields are declining more rapidly than anyone would have imagined, and most major oil-producing nations (like Iran, Venezuela, Libya) have no way of attracting the desperately-needed foreign investment to help arrest the decline, let alone identify new discoveries.

These countries (and many of the other leading oil-producing nations) have been run by despots who have systematically looted the lucrative profits generated by their respective national oil companies for decades, with little or none of the money reinvested in replacing or even sustaining production.

I regard copper and oil, two of the best indicators of world economic growth, to perform strongly in the years to come.

Emerging world demand is growing and at the same time they have inherent supply-side problems that won’t be resolved overnight, particularly oil.

So returning to our central theme, it’s important to remain calm and ignore the frenzied headlines that one is exposed to on a daily basis.

Remember that the world is on an inexorable growth path, led by China and India, with commodity demand to remain strong for the at least this decade and the next.

Retain your perspective, even when everyone else is losing theirs.
 
Gavin Wendt is the founder of MineLife, publisher of the MineLife Weekly Resource Report